Occasional musings on startups, entrepreneurs, venture capitalists, and all things San Francisco.

05/15/2016

Making great early stage venture investments is first and foremost about finding great people. So, when people whom I respect tell me there is someone I should meet, I always take the meeting. Such was the case when Ariel Poler, an entrepreneur, angel investor, and good friend, introduced me to Oskar Hjertonsson in 2013. Ariel originally hails from Venezuela and consequently is sought out by many high-quality LATAM entrepreneurs. Oskar co-founded a company called Needish in Santiago, Chile with Daniel Undurraga and Juan Pablo Cuevas. In Q1, 2010 Needish launched ClanDescuento - a Groupon-like service. Needish was acquired by Groupon less than 6 months later and was generating more than $10m per month in revenue by 2011.

When Oskar and I first met he had moved from Santiago to right across the street from me in San Francisco and was launching a new group-photo service with Dani Undurraga called Seahorse. I was skeptical of this direction given the competitive nature of the category and how much it diverged from the area in which they were previously successful. It wasn’t that I thought great entrepreneurs can’t be successful in different markets – they can. It was more my belief that these particular entrepreneurs had a unique set of knowledge and experience that could be applied very successfully to something closer to their original success.

Seahorse ran it’s course and although the team could have pursued a sale at the end of 2014, such a sale would have come at the expense of indentured servitude for the team, which, given their ambitions, they weren’t willing to do. At the same time Seahorse was winding down, Oskar and Dani’s third partner from Needish, Juan Pablo Cuevas, was leaving Groupon after having successfully run Groupon Latin America for several years. The Needish band was back together and this time with an idea more in line with their prior success. In January 2015 Cornershop was born.

Having spent nearly two years living in San Francisco, Oskar and his wife Alessandra had become regular customers of many of the venture-backed on-demand startups. The one they liked and patronized the most was Instacart. While the demand for such services has proven to be strong, much has been written about some of the challenges with their business models, specifically bad unit economics driven by labor costs. Cornershop provides a service similar to Instacart that benefits from the same demand and loyalty, while operating in a market where labor costs are ¼ of what they are in the US.

In very rare cases where I know the founders well, I will make a personal angel investment. Given my ~2 years of getting to know Oskar and understanding how he and his partners worked, Cornershop represented one of those rare cases. My personal investment in 2015 gave me the opportunity to work even more closely with Oskar and the other Cornershop founders – to see how they thought, how they solved problems, and how they executed. By the time Cornershop had reached the point of raising a Series A, I’d had almost a year of being able to evaluate both the opportunity and this team executing on that opportunity. It is clear to me why they were so successful last time and I’m very happy to be a part of this journey with them as they look to do it again -- this time even bigger.

09/13/2015

Anyone who has been involved with startups for the last 20 years has been steeped in the culture of what it means to build Agile software. Agile development has become so accepted as the best practice in software development that it’s hard to imagine startups doing software development any other way. It’s easy to understand why: The Lean Startup, MVP, and Product/Market-fit would be nearly impossible to achieve using any other approach to software development.

That sounds like the way the best startups are managed for every functional area. The best startups are able to attract great people, empower those people and iterate quickly in every functional area. They refine, they adapt and they are agile. At Jackson Square Ventures (JSV) we look for founders who have demonstrated these qualities.

Agile principles can, and should, also be applied to the way a venture firm works. Having seen first-hand the benefits of an Agile approach to startups it only makes sense that many of the aforementioned 12 Principles can be applied to making a venture firm function better, and in so doing, improve performance. At JSV we operate by many of these principles. Our highest priority is to satisfy the entrepreneur through early and continuous delivery of value. We welcome change and adaptation throughout each company’s journey and we work closely with our entrepreneurs to identify where changes need to be made. We know building a great company requires persistence, patience and lots of iteration.

Similar to the Agile principles, our most important job as venture capitalists is to support the motivated entrepreneurs we back and give them the support they need to get the job done. The most efficient and effective method of providing input and feedback to our entrepreneurs, both positive and negative, is face-to-face. Board meetings are important, but are just a starting point. Yet we know that what we are doing is providing feedback, not running the company. The only thing worse than a VC that isn’t engaged is one that keeps trying to grab the wheel. At JSV we support our entrepreneurs while allowing them to drive the car.

Another Agile principle states, “Simplicity – the art of maximizing the amount of work not done – is essential.” Complexity creates more work; simplicity reduces unnecessary cycles. Yet, counter-intuitively, complexity is much easier to achieve than simplicity. Whether it’s in UI design, system architecture, messaging, or dialing in a sales process, it’s always easier for startups to do more than to cut away to the bare essentials and get it right.

Venture capitalists suffer from the same challenge, but for VCs it’s about doing more deals, investing in many different stages, and investing in every “hot” sector. The trade-off between simplicity and complexity is a trade-off between focus – doing less – and not. We preach focus to our entrepreneurs and we live it as a firm. When we spun JSV out of our predecessor firm, we had first-hand experience of the sclerotic effects of having a relatively large team of partners with a large portfolio and a broad investment mandate.

The final Agile principle states that for a team to continue to be effective, it must continually evaluate what’s working and what’s not and adjust accordingly. That process of reflection is what led us to start JSV. We evolved and adapted over 14 years in the venture industry. We dropped the previous name that wasn't working. We dropped investment areas such as semiconductor and clean tech. We dropped Menlo Park in favor of San Francisco. We chose to focus on what worked -- early stage investments in software companies. We are very happy with what we have achieved so far and are committed to continuing to reflect and evaluate to make us a firm that our entrepreneurs are proud to call their partner.

08/26/2015

The emergence of the ‘seed round’ combined with the technological advances that allow companies to get further with fewer dollars have created an embarrassment of riches for venture capitalists that focus on companies at the Series A.

Today raising a little bit of seed capital has evolved into raising a “seed round” and while it’s still not a requirement, it is something that the vast majority of companies that receive venture capital do. That was not always the case. Angels have been around since before the first venture firms, but through much of the history of the venture capital industry, traditional venture capital firms were a large source of seed capital for early stage ventures. Yes, angels participated in many deals and at times provided the earliest seed funding absent an institutional venture firm. But, having seed capital from angels prior to raising a venture round wasn’t a necessity. Now it is.

The emergence of the “seed round” as an investment stage prior to venture capital started with the explosion of capital at the seed stage. Three factors have combined to funnel an abundance of seed stage capital to startups.

First, by any measure, there has been a proliferation of angels. Individual angels have always been a part of the technology startup landscape. Historically they were successful entrepreneurs who were seeding the next generation of technology startups often times in the sectors where they had themselves achieved their success. But, starting with the Internet boom and followed quickly by Google, and then later by Facebook and many companies since, the number of angels looking for startups to support has mushroomed.

The second piece of the puzzle has been funneling this abundance of angel appetite into worthy startups. Angels used to be limited by their personal networks, which made angel investing work best for only the most connected people. But then in 2010, Naval Ravikant and Babak Nivi launched AngelList and overnight every angel could find more than enough deals to fill their dance cards.

The third factor helping to drive this abundance of very early capital has been the institutionalization of seed investing. Venture firms have always made seed stage investments, but the bulk of their precious capital and even more precious time has always been spent on the investments they manage from beginning to exit. The “seed round” becoming the norm rather than the exception has created an opening for a new category of venture fund, the seed stage fund. Until Ron Conway launched Adam Ventures in 1996, there was no such thing as a seed stage fund, just individual angel investors and venture investors. Now there are new seed stage funds being started every day. These seed stage funds provide a vital function for many individual angels by providing much-needed signaling on what deals are worthy of support. This combination creates a virtuous cycle, more seed stage funds, leads to more deals seeded by those funds, which creates more quality deals for individual angels to fund. This proliferation of startups receiving a “seed round” creates an embarrassment of riches for Series A venture investors.

In addition to this rich field of vetted companies to select for investment, Series A investors also have the benefit of companies being further along at the time of their Series A.

In my prior life as an entrepreneur, I started three different companies. By the time I got to my third one in 1997, an enterprise software company that I started with a partner, we used seed capital (much of it ours) to build the business plan and then used our Series A investment, from two top-tier venture firms, to get our first product out the door and our first customers signed. We had 6 customers and were out talking to investors about raising a Series B in mid-1999 when we were given an offer we couldn’t refuse to sell the company.

Contrast that with startups today. Most of the startups we’re backing today have raised a “seed round” of $500k - $1m and with that are able to ship a product and get paying customers. It took us over $4m in 1998 to do less than what many companies can do today with only $500k.

Now back to that embarrassment of riches. While “seed round” deals are especially difficult to track, one of the best sources of data, CB Insights, shows a continuously widening gap between the number of companies receiving “seed rounds” and the number of companies receiving Series A rounds.

Truly great teams can achieve meaningful traction with small amounts of capital. When you combine that with the explosion of seed stage funding that is giving so many teams a shot, it’s like throwing a bunch of spaghetti against the wall to see what sticks. And there is a lot that is sticking!

03/03/2015

I was having a conversation recently with a colleague who invests in venture capital and private equity. We were talking about some of the challenges of investing in early stage companies and specifically about picking winners amongst a group of early stage opportunities. She likened picking winners in the early stage to choosing the winners in a kindergarten class filled with 5-year-olds. How can you know at that stage which ones will be the winners? Yet there are firms which have, over long periods and in different markets, been able to pick a high-percentage of winners at the earliest stages.

Some firms say it’s all about the people. Others say it’s all about the markets. For us, it’s both coupled with a lot of hard work. I don’t often write about portfolio companies, but it’s easier to understand what I mean by taking the example of an early stage investment we made a while back in ToutApp. ToutApp is on the trajectory of a winner.

It’s all about the entrepreneur… Without great entrepreneurs, there would be no successful startups. Great entrepreneurs are the cornerstone of success. There have been many books written about the characteristics of great entrepreneurs, but for me a few characteristics rise to the top. They are both wicked smart and incredibly humble. They know a lot and have a strong conviction for their vision, but they also know that they don’t know everything and need to actively seek out counsel from others with more experience. The great entrepreneur seems to always be on the lookout for the flaws in their thinking. And finally, a great entrepreneur is tenacious - failures are but momentary setbacks from which much can be, and is, learned.

When I first met ToutApp founder and CEO Tawheed Kader (TK), I thought he exhibited many of the characteristics I look for in great entrepreneurs. He was clearly tenacious and resourceful having grown his small team of 6 to almost $1m in ARR mostly through force of will. But it’s only through working with an entrepreneur over time that you can truly judge. Having watched TK operate over the last 15 months, I’m even more convinced today that he exhibits the characteristics of a great entrepreneur than I was when we made our initial investment. He is not just tenacious, he is smart, humble, driven, and focused. I consider myself lucky to be helping him build his vision.

Of course, great entrepreneurs are necessary, but not sufficient. To pull the trigger on an early stage opportunity we also have to see a great market, and ToutApp is going after a huge market ripe for a solution like theirs.

Since the dawn of the internet, sales and marketing have been going through a major transformation. I benefited from the early innings of that transformation in marketing first as the co-founder of a marketing automation company, Connectify, that sold in 1999. I did so again as an early investor in a very successful B2C marketing company, Responsys. A big part of the transformation of marketing that Connectify and Responsys were a part of has been using everything you know about your prospects to deliver the right message at the right time. And while marketing will always have a role to play there, often the person who knows best what message to deliver and is also able to deliver that message most effectively is the sales rep. Ultimately they close the deals. The technology should allow sales people to become mini-marketers. Who better to know what message is the right message than the sales person.

CRM has done an amazing job of helping to systematize sales over the last 15 years, but it was built for sales managers. What sales people need is a platform that enables them to do a more effective job of communicating with their prospects to close deals and drive revenue. What sales needs is a sales platform for sales people - and that’s exactly what ToutApp is delivering.

This is why over the 15 months since our initial investment they have added hundreds of new customers to the platform, maintained a >150% Direct Dollar Renewal Rate, grown ARR by >3x and grown the team by >5x. All of that progress has caused others to sit up and take notice. And today the company is announcing another major milestone - that we’re adding a fantastic new investor to the team and board - Scott Weiss from Andreessen Horowitz. With the right combination of a great entrepreneur and team, great market opportunity and lots of hard work, ToutApp is building a true market leader. I am excited about the future of ToutApp and look forward to working with TK, Scott and the entire team on the next stage of growth.

08/12/2013

"50% of my advertising budget is wasted, I just don't know which 50%" John Wanamaker

John Wanamaker was an early department store owner and innovator who was born in 1838. Replace "advertising" with "marketing" and you have a refrain that is familiar to generations of business execs. It's hard to believe that a quote attributable to a man born almost 180 years ago is still widely cited by marketing execs today. Unfortunately for Mr Wanamaker, future generations aren't likely to cite him quite as frequently. That's thanks to the fundamental transformation of marketing that started 15 years ago with the commercial development of the internet and has accelerated in the last 5 years as digital marketing has matured.

This transformation of marketing is as real for consumer marketers as it is for business-to-business marketers and for big companies as it is for small ones. But while big companies have the human and financial resources to experiment, their DNA makes it very difficult for them to fully embrace these changes. Old habits die hard. This creates new opportunities for smaller companies and startups who have less ability to dabble, their limited resources force them to focus. As a venture capitalist who invests in early stage companies, this transformation is a wonderful thing. Historically startups have had to innovate on one dimension - product - and then fight it out with incumbents where the rules of the game are well understood by both startup and incumbent. Now startups can innovate on product AND go-to-market. Startups that innovate effectively on go-to-market are able to tip the playing field even more in their direction away from incumbents.

Marketing is now accountable.
When you live in a world where it's acceptable to waste 50% of your budget, and effectively none of that budget is directly attributable, you tend not to have strong accountability. Marketing has traditionally had softer metrics than other parts of the organization. The classic struggle between marketing and sales was that marketing was responsible for delivering leads (Marketing's quantifiable metric) and sales would always complain that the leads marketing delivered were garbage. In today's world, neither of those things are acceptable. The tracking enabled by digital marketing provides the foundation for a rich set of metrics that can, and should, be used to hold marketing accountable. Every marketing program or initiative can be measured, and since it can be measured, it can be more effectively managed. I often tell engineering founders that they should think of marketing as an engine that they can build, tweak, and optimize - it's no longer a black-box. I've seen this change manifest itself in the way portfolio companies track and report KPI's or Key Performance Indicators. When I started in the venture business 10 years ago, the bulk of the KPI's were owned by sales or, in some cases, operations. Now if the marketing department isn't responsible for a majority of those KPI's, they are at least responsible for a plurality. It's not OK in the startup world for marketing to hide behind soft metrics.

The same channels of communication don't work any more.
Gary Sevounts, the VP of Marketing at Zetta.net recently told me that Google is the new Gartner. It used to be for enterprise technology purchasers, the analysts were their primary source of independent information. Now all users have to do is search Google to find a treasure-trove of relevant and independent information about any vendor and it's competitors.

There has also been a move away from traditional paid advertising to get your message out and towards earned media and content marketing. Prospects don't want to be told what to do in this new world. They are telling marketers and companies what they want when they want it. This means that a marketers job is no longer to just deliver a message through a megaphone, but to listen and provide prospects with easy on-ramps to learn about their wares.

Most channels of communication in the past evolved in a world where mass communication was the norm. As a result, marketers were used to blasting their message out to huge audiences hoping to score a few hits. It used to be acceptable, for instance, to spend oodles of money on a trade-show where only a small percentage of attendees might be receptive to your message. Why would a sophisticated marketer today use such a blunt instrument when they can engage target prospects who are receptive through webinars that are available when the prospect wants.

It's no longer about awareness, it's about engagement.
Marketing has historically been primarily about awareness - the tippy top of the funnel. Marketing is moving further and further down the funnel as companies are trying to be more efficient and their go-to-market gets more economical. We're already seeing with many of our companies that marketing's job is to land the customer - get them to pull out their credit card and start paying. It's then sales job to upsell them and grow that customer over time. In order to get a prospect to that point, you need to do more than just inform, you need to engage. Engagement can happen many different ways. It can mean getting the prospect to share, in detail, the problem they are trying to solve and the shortcomings of their current solution. It can also mean getting the prospect to actually start using some part of the product. In many cases, engagement means both of those things and it culminates in the prospect already having used the product through a trial becoming a paying customer without ever having interacted with a sales person.

Now there is a Marketing Pipeline too.
The pipeline has long been associated with sales activities. Over the last 20+ years, sophisticated enterprise solutions have been built around managing that sales pipeline. The largest SaaS company today started out as a solution for managing that sales pipeline as their name suggests: Salesforce.com. The majority of our companies are now also talking about a marketing pipeline and managing prospects through that pipeline. I mentioned above the KPI's that marketing is now responsible for - in many cases, those KPI's are associated with different stages of the marketing pipeline. The marketing pipeline can be thought of the stages of engagement a company wants to take a prospect through before turning that prospect over to sales. In a company where the Marketing Pipeline is rigorously managed, Sales no longer has to worry about getting poor quality leads.

The tools of the trade are evolving.
Just as it took more than 20 years for the tools for managing the sales pipeline to evolve to their current state of maturity and ubiquitous use, it is likely to take a while for the tools that manage the marketing pipeline to mature enough to be used ubiquitously. Even today, if you use all of the best tools that exist, leading edge companies still need to integrate their product/customer interface into the marketing and sales pipeline. This integration can range from demos of specific functionality all the way to full-fledged trials of the product. These "Product qualified lead" - leads that have already engaged positively with the product - are for many companies, the only leads worth following up on.

A more scientific and accountable approach to managing marketing is better for everyone: investors get to see how their investment dollars are put to good use; sales gets higher quality leads; and the CEO can hold Marketing fully accountable and replace the Marketing exec if he/she can't deliver.

06/28/2013

Scalability is the first stage of success for an entrepreneur and his or her early stage venture investors. It’s when the concept is proven and the business can grow. This means that all parts of the organization are ready to expand to meet demand.

When most people talk about scalability, they are talking about revenue scalability and while that is important, it is not a sufficient prerequisite for success. A business has reached revenue scalability when growth becomes more formulaic, meaning that with a certain number of inputs (investment capital, employee productivity, etc.), a reasonably predictable number of outputs can be achieved (new customers, revenue, bookings, etc.).

Achieving and maintaining revenue scalability isn’t about getting any one thing correct. It is a complex, multi-dimensional challenge. Each of the different elements of revenue scalability reach break points at different levels. The methods that were effective in generating leads sufficient to grow to a $50-million business may not be enough to grow the company at the same rate to $100 million in sales.

By the same token, effective sales can change dramatically at different levels of scale. In the earliest stages of many companies, all sales are person-to-person directly made by the principals, but this doesn’t scale. Successful companies must put in place an effective sales organization. At an even larger scale, companies need to work through partners and channels to efficiently reach enough customers to effectively grow.

The specifics of these revenue scalability challenges will differ from company to company, but there is one aspect of the challenge that is the same for all companies: the critical component of hiring the right people. In the rush to hire employees to help meet increasing demand, companies often stumble by hiring the wrong people. Those mis-hires can take what was once a promising growth company and consign it to the dustbin of history. Revenue scalability is complex and important.

But scalability is more than that…

The scalability of most technology businesses is dependent on things beyond revenue scalability. For many tech businesses, service scalability and product or design scalability are at least as important as revenue scalability.

Service scalability is when the demand of expanded users can be met. Friendster may have been Facebook — and Facebook not much more than a cool app for students at Harvard — if not for the fact that Friendster was unable to scale its service. Friendster’s service performance was great when it had 100,000 users, but it degraded to the point of being unusable when it had several million users. Facebook deserves credit for building a service that was able to add massive numbers of new users without impacting the overall quality of service. For many tech businesses, service scalability is a proxy for “does it work.” Especially today, when many tech businesses are services delivered in the cloud, the ability to scale service to deliver a delightful experience to users is imperative. If a company can’t do that, it will fail.

Product or design scalability for enterprise applications generally encompasses breadth of support. For the first few customers, the environment supported is fairly limited. But to scale the business to hundreds or thousands of customers, the product will have to support many more user cases. For marketplace businesses, this is literally how the service is designed. The design of a marketplace that worked for thousands of listings, is unlikely to work when the marketplace has 100s of thousands or millions of listings. Product or design scalability is crucial.

Scalability is a job that’s never finished…

Managing scalability in any business is a never-ending process. The things that allow a company to scale sales today may not work tomorrow. The architecture that handled one million users probably needs some work to support 10 million users. And the design that allowed a marketplace to support tens of thousands of transactions probably won’t work for millions of transactions. This is as true for a startup as it is for a mature business. Investors at every level — from venture investors to public-market investors — are always on the lookout for signs that businesses can handle scaling and are making investment decisions based on scalability.

05/24/2013

For year's we've been hearing about how the
ascendant tech startup scene in NYC is going to rival Silicon Valley's
tech-hegemony. It's a story the MSM has run with hard because, after all,
NYC is the apex for the main-stream media and, who doesn't like rooting for the
home team. For those NYC cheerleaders (I'm talking to you Bloomberg and
WSJ), Yahoo's purchase of Tumblr was solid confirmatory evidence
of the momentum-shift they've been trumpeting. Yet, while the acquisition
was clearly a good thing for Tumblr's founder and early backers, it was at
best OK and at worst a bad thing for NYC's quest to challenge Silicon Valley's
tech-dominance.

The confluence of elements at the core of Silicon
Valley's vibrant tech scene have been long discussed - fantastic universities,
access to capital, and access to a strong startup support system. NYC
long had great universities and human capital (although not as much tech-DNA),
but somewhat surprisingly for the financial center of the world, NYC just
didn't have a strong startup funding culture. To be clear, there is
plenty of wealth to be invested in NYC - somewhat ironically there are 5-NY-Metro-Area hedge-fund titans who each made
individually more in 2012 than the entire purchase price of Tumblr.
Lots of money, just not lots of it going to tech startups. Another
way to put it is that there are lots of billionaires, just no
tech-billionaires. In the last 10 years, at least the money side of the
equation has been looking better for NYC. According to the PWC/NVCA
MoneyTree, NYC's share of venture investment dollars grew from 5.8% of the US
total in Q1 2003 to 9.8% in Q1 2013. NYC is taking venture investment share
from other markets. But it's not taking it from Silicon Valley.
Over that same period, Silicon Valley's share of US venture investment
dollars went from 32.5% to 37.9%.

So what is NYC missing and in what alternate
universe could the Tumblr acquisition be bad for the NYC tech
ecosystem? What Silicon Valley has in abundance that no other tech-center
rivals is what I will refer to as the anchor-tenant companies.
Anchor-tenant companies are those that become large independent and
growing tech leaders. They continue to generate wealth; their alums
continue to spawn new companies; and and they continue to buy interesting
startups fueling the cycle. There are tech giants in places other than
Silicon Valley (Microsoft, Amazon, IBM), but no area rivals the valley for the
sheer number of these tech titans. Silicon Valley has them in every
corner of tech and continues to create them. Just since the tech bubble
burst, we've added LinkedIn and Facebook (started post bubble) and Google and
Salesforce (IPO post bubble) to name just a few.

This brings me back to Tumblr. A great
company and a great outcome. But now that the music has stopped
and Tumblrhas taken a chair, the company has stopped playing for the big
leagues. Tumblr may ultimately become as meaningful toYahoo as
YouTube has become to Google as Yahoo CFO Ken Goldman implies,
although I'm skeptical. But even if it reaches that lofty status it will
be bitter-sweet for the NYC tech community. Because instead of having a
large independent tech giant around which an ecosystem can flourish, NYC will
have a large satellite division of a Silicon Valley based company.

03/28/2012

I wrote the following piece after returning from a trip to India in 2004. This is as urgent an issue for Silicon Valley and the competitiveness of the US Economy today as it was then. While I wrote this about India, we need to be just as concerned about China and Eastern Europe.

February 23, 2004

Silicon Valley is suffering a brain drain that is just going to keep getting worse.Historically the valley has been the beneficiary of brain drains from around the world.The diasporas of China, India, Russia, etc, all came to sunny California to start their companies and make their fortunes.Companies like Juniper, Q-Logic, Exodus, and Silicon Labs are among the hundreds of companies that have generated billions in sales and wealth started by the best and brightest from around the world.Now some of those great minds are packing up and heading home.

I spent the first week of February in India with a TiE delegation of other venture capitalists and TiE Charter members.Everything you’ve heard about how exciting and dynamic things are in India today is true – if anything, it’s understated.Politicians and labor unions who are expressing concern about US call center and SI jobs going to India are focusing their energies on the wrong problem.The problem is not the inevitable transfer of certain business functions to where they can most efficiently be performed, but the migration of the entrepreneurs and experienced workers who create the companies (and the wealth) to their ancestral homelands.

We’ve all heard the stories about the quality of the Indian workforce.They’re smart, they’re well educated, and yes, compared to engineers in Silicon Valley, they’ll work for peanuts.But there are two critical pieces of human capital that India (and countries like it) lack that Silicon Valley has in spades.The first is years of relevant experience – each new generation of technology building on the successes and failures of the one that came before it. The second is the high-tech entrepreneurs – the people who have worked in an industry for long enough to know how things are done and to know where the problems are that are worth solving.But there’s nothing genetic that leads these shores to produce more entrepreneurs than anywhere else.

For the last 30+ years, the best and brightest from around the world came here.They first came here to get educated.That’s why the graduate programs at our top engineering schools are filled to overflowing with the best and brightest from India, China, Russia, and everywhere else around the world.The world’s Diaspora came to the US to get educated.And then once educated, they realized that the companies that would put all that good education to best use were companies right here in the good ole U-S of A.If they happened to be in an area where companies are started as fast and furious as they are in Silicon Valley, they may have gotten the idea and tried to start one themselves.They built up that critical experience and some even became one of our most treasured natural resources: the entrepreneur who innovates, creates jobs, and creates wealth.

Now some of those people are heading home.So now those bright engineers who graduate from IIT with arguably the best engineering education in the world won’t be forced to reinvent the wheel.They’ll have mentors who learned their trade through years of hard work in the valley and elsewhere.And some of those that head back will be the entrepreneurs with the ideas and the initiative to start high-tech companies that are ready to compete on a global scale.

We now have our own Silicon Valley Diaspora to moan about - the best and the brightest leaving these shores for bigger and better opportunities elsewhere. So watch out.While the first wave of Indian high-tech startups was dominated by call-center and IT outsourcing firms, the next wave is likely to be dominated by software and hardware companies that build their entire companies – not just their call-centers and back-office – somewhere other than Silicon Valley.

03/23/2012

The JOBS Act is a good thing for Silicon Valley and the whole startup ecosystem. Josh Kopelman is correct when he points out that IPO's over the last 10 years have happened later in companies' development than was previously the case and this has taken from public market investors the opportunity for tremendous value creation. Dan Primack also makes a valid point that VC's have three options for exiting their portfolios: sell them, take them public, or shut them down. But making SarbOx the sole scapegoat for why IPO activity has been anemic since 2000 is just as wrong as claiming it's the savior that has kept the public markets from suffering losses from failed companies that manage to go public. Like @pkedrosky, I still believe Groupon will end up with gnashing of teeth and tears for investors of all stripes.

It's an oversimplification to blame the IPO market of the 2000's on SarbOx. To understand the market during this period, you have to first remember what happened before it. Anyone who was a part of the startup ecosystem during the bubble was, at least up until now, permanently formed by their experience. It's like my grandfather, a child of the great depression, who 60 years later was still untrusting of banks and more frugal than anyone 10 years his junior. The memories of public market investors aren't quite as long, but the hangover from the crash certainly lasted well into the 2000's. When you think of how high the bar was for tech companies to go public post the bubble, just remember how big Google was when they finally went public – they were almost $1B in revenue in the fiscal year before their IPO. A size that was completely unheard of in the venture-backed IPO world prior to Google. In fact, the year that SarbOx passed, Google's revenue was $348m – a number that was well beyond what was needed to go public for any venture backed tech company up until that time.

At the time of Google's IPO, many were hopeful that it would usher in a new era of venture-backed IPO's. Sadly, it did not. And while the hangover was partially to blame, and SarbOx played a role, there was more to it than that. Three other major transformations of the landscape, both before and after the bubble, have helped to make early venture-backed-IPO's more than a little challenging.

The first of those challenges was the "death" of the Four Horsemen. During the 80's and early 90's, the bulk of venture-backed IPO's were done by four west-coast boutique investment banks – Robertson Stephens, Alex Brown, Hambrecht & Quist, and Montgomery Securities. These banks made a great business out of doing smaller IPO's and the then denizens of Sandhill Road didn't see using them, versus a bulge-bracket firm, as a sign of weakness. The late 90's changed all that with the larger IPO's that were able to get done during the bubble. Once the fees got bigger, the bulge-bracket firms swooped in. As they did, it became a badge of honor to have a bulge-bracket firm lead your IPO squeezing out the boutiques. Over time, the Four Horsemen were all bought and no boutique-banks have managed to fully take their place – at least not to the extent that the Denizens of Sandhill road will allow them to lead their companies' IPOs.

The next two challenges were more structural changes to the market. The first of those was the Global Settlement between Elliot Spitzer and the 10 largest investment banks, a topic Henry Blodget is all-too familiar with. In an attempt to remove the inherent conflicts of interest that existed between investment banking and research at these firms, they managed to throw the baby out with the bath-water. What small IPO's need is marketing, and research is marketing. If you try to take a company out and no one is talking about it, no one will trade it. That tends to tilt the field towards companies going public only after they have become household names which usually implies much larger companies.

The last nail in the coffin (not necessarily in chronological order) of smaller venture-backed IPOs was decimalization. In late 2000, the NYSE started to move from trading in 8th's to trading based on decimals. The biggest impact of this was on the spread between the bid and the ask. If you're trading in 8ths, the spread scale can be 12.5 cents at a minimum and go up from there and when you trade in decimals, the spread between the bid and the ask can be as little as a penny. Market makers, the guys who keep a stock trading, make their money on the spread between the bid and the ask. And when that spread is squeezed, they make less money. This is all good and well for a company like Apple who trades upwards of 20m shares a day, but for a small-cap stock that trades <100k shares a day, what they really need are market makers. And if you can't make money on the spread, who wants to make a market in the stock.

There's a lot there, and I'm sure there are other subtle changes in the market and landscape that I've missed. But on the bright side, we're finally getting over the hangover and the JOBS Act may have come along right at the perfect time. There are more and more players every day who got into the game after the bubble. What we need now is for a few of them to take their companies public early and be successful for public market investors. Once that happens, all these challenges will wash away and we'll have a healthy venture-backed IPO market again.

04/06/2011

While there certainly are some frothy valuations in certain parts of techdom, it's difficult to call it a bubble -­ at least not when compared to the Internet Bubble. The Bubble 1.0 tide rose all boats. It didn't matter what sector you were in, if you put “.com" at the end of your name, you immediately achieved valuations that you wouldn't have imagined in your wildest dreams. It didn't matter if you were selling low margin products like aspirin or pet-food; Dot-Com-it and you were a darling. Bubble 1.0 was also characterized by an obscenely large amount of venture capital. At the height of the Dot­Com mania in 1999, venture firms invested $100B. As a result of this flood of investment dollars, every good idea had 10 well-funded companies chasing it.

As has been often pointed out, a large portion of Bubble 1.0 companies didn't even have business models. They were valued on such esoteric metrics as eyeballs, clicks, or page-views. For the few who actually sold things and generated revenue, their values seemingly were higher the more money they lost, as long as they could spin a story about how losing even more money allowed them to grow faster. I remember well a conversation I had at the time with Pat Connolly, the CMO of Williams-Sonoma who was bemoaning the fact that Wall Street measured him on boring things like gross-margins and profits, but all of his startup competitors weren't held to the same standard.

Finally, during Bubble 1.0, public market valuations were bubblelicious even for large non-Dot-Com companies. Cisco, Microsoft, and Oracle had P/E ratios of 150+, 78 and 120 respectively (I can't say how high Cisco actually was because my reference source stops at 150!). Even GE, hardly a fast growing tech company, sported a PE north of 45. For large-cap companies, those are impressive valuations indeed.

Fast forward to the "Bubble" many commentators are claiming we're now in, Bubble 2.0. By virtually any measure, if you use Bubble 1.0 as your yardstick, we're not in anything close to a Bubble.

The primary argument that is being made for a new bubble are the fantastic valuations that the big 5 ­(Facebook, Twitter, Groupon, Zynga, and LinkedIn) ­are getting on the secondary market. In these markets, buyers and sellers don't have access to the same information. For most of the buyers, it is a momentum bet on the assumption of the existence of a greater fool. That said, unlike the last time, with the exception of Twitter, these darlings all have business models that are generating tremendous revenue growth and, if the buzz is to be believed, are incredibly profitable. We'll see when their numbers all become public whether these secondary market buyers were all "greater fools" or savvy trend pickers.

Go beyond those 5 and the signs of a bubble are pretty weak. Starting with the amount of money that venture firms are investing, today it is fully 1/5th of what it was the last time,­ a "mere" $20B. As a result, there aren't 10 well-funded companies chasing every great idea. What about all the "super-angels" you ask? They certainly make getting capital to start a company much easier, but once the company starts growing, in all but the rarest of cases, it still needs capital to grow. With less venture capital going in, there are fewer competitors with the capital to effectively scale their businesses.

Aren't VCs paying crazy valuations again?­ What about FourSquare's rumored $400m valuation, or Quora's rumored $85m valuation for their first round when they had just a few people and an idea. Heady valuations for sure, and not having been a part of the partner discussions when those decisions were made, I don't know what arguments used to justify them - but I can guess. Heady valuations for "Hot" and "Darling" companies are nothing new in Silicon Valley. And sometimes they even pay off. Google was a "hot" company with a seemingly outlandish valuation at the time and that seemed to work out just fine for everyone. There are always a few companies that, based on the charisma or track record of the founders or some particular set of stars aligning correctly get fantastic valuations. There are always the exceptional startups that generate the exceptional venture valuations. As I discussed previously, this sort of exceptional valuation is far from a guarantee of investment success.

Finally, look at public market comparables: they aren't even close to flashing red, I don't think they are even yellow. Back to the big three last time around and their average P/E, today the three highest profile public tech companies (who also happen to be the largest by market cap) are Apple, Google, and Microsoft, which together have an average PE ratio of 17.6. Far, far below the levels reached during Bubble 1.0.

Silicon Valley has been built on a series of major innovation waves. With each new wave comes some new mega-winners. We're in the opening stages of waves in social-media, hand-held computing, the consumerization of IT, Infrastructure 2.0, and the move of many IT functions and services to the Cloud. We haven't even scratched the surface of these opportunities so it seems a bit premature to be calling it a bubble. So for all those people paralyzed in fear of a Bubble, stop being a Chicken-Little and go out there and innovate!